The Predictive Power of REIT Implied Volatility and Implied Idiosyncratic Volatility

Abstract

Executive Summary. This paper examines the characteristics of real estate investment trust (REIT) equity options and the predictive power of ex ante risk measures obtained using option prices. In 1996, only 5% of REITs had traded options while that number increased to 35% by 2006. The average volume and open interest for REIT options has increased tenfold since the beginning of this decade. There has been no prior empirical work on the nature and predictive power of REIT-implied volatility. We find that REIT-implied volatility and implied idiosyncratic volatility distributions are similar to those of other listed equities. We also find that both realized and implied total volatility are related to future realized volatility for REITs. Realized and implied idiosyncratic volatility are also significantly related to future realized idiosyncratic volatility. These results establish the important predictive power of these volatility measures for REITs.